Preferred Shares for China Banks Supported, but Direction from Gov’t Lacking; There is divergence, for example, over whether preferred shares should be classified as equity or bond investment for accounting purposes

09.17.2013 18:06

Preferred Shares for Banks Supported, but Direction from Gov’t Lacking

Financial institutions already preparing for launch, sources say, but are waiting for regulators to clear up range of issues

By staff reporters Wen Xiu, Zhang Yuzhe and Zheng Fei

(Beijing) – Despite overwhelming support for preferred shares in the banking industry, there is no consensus yet over how the financing instrument should be designed and regulated. Many banks have been preparing to launch preferred shares, but they need regulators to clear away legal ambiguity, sources from banks said.Preferred shares are a bond-like securities that do not give investors voting rights, as common stock does, but holders can usually expect a steady flow of returns and have prioritized claims on the issuing company’s assets in the event of a liquidation. Preferred shares are traded through private placements in the primary market and are not available for public trading in the secondary market.

Central bank officials including the governor, Zhou Xiaochuan, have advocated the introduction of preferred shares as a much-needed addition to domestic banks’ fund-raising tools. Zhou says the government’s equity holdings in banks are better represented by preferred shares because they can reflect the cost of capital without exerting undue influence on the lenders’ daily operations.

The chairman of the China Banking Regulatory Commission, Shang Fulin, has urged banks and concerned financial regulators to work together to develop financing instruments including preferred shares to replenish banks’ capital.

The current regulatory floor for big commercial banks’ tier-one capital adequacy ratio is 11.5 percent. By the end of June, the Big Five state-owned banks all met the requirement, but the pressure ahead remains huge because subordinated bonds will be phased out as a qualified tool for capital replenishment.

Many experts have proposed preferred shares as a substitute for subordinated bonds. But the country’s Company Law, in effect since 1994, does not mention preferred shares.

The legal gap is the major reason why previous efforts aimed at introducing the financing instrument have not gained much progress, Zhou wrote in a signed article published on the central bank’s website last week.

The Accounting Question

However, the China Securities Regulatory Commission (CSRC) may be moving closer to solving this problem. In a seminar the CSRC held with industry experts in May, the regulator said: “There are no substantive legal obstacles against issuing preferred shares.”

By not mentioning the concept, the Company Law has left ample space for introducing preferred shares, the regulator said. Some provisions in the Securities Law may conflict with some of the characteristics of preferred shares, but the State Council, the country’s cabinet, can issue documents to reconcile the conflicts, the CSRC said.

“Preferred shares have been popularized in foreign markets as a mature and widely known capital instrument,” a bank executive said. “As long as the domestic legal and institutional framework is done, there is no difficulty in expanding the scheme.”

This view is shared by many in the banking industry, but there is less agreement over how the new financing tool should be designed.

There is divergence, for example, over whether preferred shares should be classified as equity or bond investment for accounting purposes. The classification depends on whether the shares come with voting rights, a CSRC source said. Without voting rights, the shares should be counted as debt, but this may cause trouble for some state-owned institutions because their debt-to-asset ratios will rise when they issue preferred shares, he said.

Some potential buyers, however, want preferred shares to be treated as equity investments. A fund manager said this is because of liquidity concerns. “If it is a bond product and most investors choose to hold them for the long term, it will be very difficult for open-ended funds to operate,” he said.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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